New tax on nonprofit salaries means less money going to the mission

The big corporate tax cut in last year’s tax bill drew most of the attention, yet a very big change has come for nonprofits: a tax bill they haven’t seen before if they pay executives more than $1 million.

Dance companies and community food shelves don’t pay million-dollar salaries, so this provision generally only applies to the big health care organizations that dominate the top of the annual Nonprofit 100 ranking.

Of the top 10 nonprofit pay packages in this year’s ranking, all went to leaders of health care providers or health insurers, with the former CEO of Blue Cross and Blue Shield of Minnesota at the top of the list.

Now there’s an excise tax equal to 21 percent of any amount north of $1 million, the 21 percent figure matching the income tax rate on for-profit C corporations.

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This new excise tax made the system just a little bit fairer to taxable, for-profit corporations, at least according to the House Ways and Means Committee majority staff report on the 2017 tax bill.

The committee staff made another, maybe even more obvious point, that tax-exempt organizations enjoy a big break so long as they honor the requirement that they use their time and money to carry out their missions. “Some may question whether excessive executive compensation diverts resources from those particular purposes,” as the staff report put it.

Of course the term excessive stands out here, for work at a nonprofit that catches a break from the tax code.

Does $3.16 million seem like excessive compensation for the leader of the Mayo Clinic? It’s a $12 billion operation with a lot of moving parts, fierce global competition and plenty of industry headwinds.

So it’s worth pointing out that as well-paid as the Mayo CEO and the others who run Minnesota’s nonprofit health care organizations are, none of the top 10 made anything comparable to the people whose names appear in the section of UnitedHealth Group’s annual proxy statement that discloses the pay for its top executive officers.

The lowest-paid of the six UnitedHealth executives on that ranking was paid more than twice what John Noseworthy was paid to run the Mayo Clinic.

Nonprofit vs. for-profit pay

UnitedHealth and the seven other big U.S. health insurance companies collectively paid out twice as much in 2017 for CEOs as they did the year before, as the CEOs were paid close to $350 million. In this analysis, by trade publication FierceHealthcare, the highest-paid executive in the industry took home more than 1,400 times what the average employee did.

That turned out to be Dave Wichmann from Minnetonka-based UnitedHealth Group, with pay added up as realized compensation including stock gains that amounted to more than $83 million.

That’s probably a better measure than what the companies use, as UnitedHealth reported paying Wichmann about $17.4 million, a little less than the CEO he succeeded at the end of the summer last year, the retiring Stephen Hemsley.

The new federal tax law also took a whack at the “performance-based” pay arrangements of public company executives that had boosted total pay and had generally been exempt from the long-standing rules that limited the tax deduction to no more than $1 million per year.

There was a transition period baked into the 2017 law, but now bonuses and other forms of performance-based compensation are no longer going to be tax deductible business expenses in the for-profit world for someone making at least $1 million a year.

The guiding principle here of leveling the playing field with taxable companies led to another change for nonprofits, too, and not just on money that goes to employees’ paychecks.

Nonprofits face an unrelated business income tax on the amount they give employees in certain kinds of employee benefits, like a monthly transit pass or parking subsidy. The new law also tossed in some new wrinkles for nonprofits in accounting for what’s called unrelated business activities.

At a minimum, the new tax law created a compliance headache for larger nonprofit health care and health insurance organizations that need to compete for talent with the likes of UnitedHealth. The rules on pay apply not to the CEO but to the five highest-paid employees. And while it may be hard to imagine Minnesota health care organizations routinely paying five people into seven figures, once someone makes the list they are covered forever.

Where that might matter is with the common practice of paying deferred compensation at the end of someone’s career, which is one way nonprofits try to come a little closer to matching the long-term compensation that might be available to somebody who goes to work at a publicly held company where stock-based pay can be used.

A better question than how nonprofits might tweak the timing and form of pay is whether the tax will affect how much they pay, and the only logical conclusion is that it won’t. Imagine the Mayo Clinic deciding to cut what it pays its CEO by two-thirds to avoid an excise tax. These new rules likely only mean that these nonprofits have just a little less money going to the mission.

And besides, we already know how boards will act by looking at what the vastly better-paying, for-profit companies have been doing. For years these companies knew they lost the deduction for anything paid above $1 million in salary, so they should have paid CEOs $1 million and not a dollar more, explaining that the CEO’s deal would also include stock-based or other additional pay.

Yet last year Wichmann collected $1.16 million in base salary. The CEO of Kentucky-based Humana got closer to $1.3 million and the boss at Cigna got just a little more.

You would have to conclude that these companies decided to overlook the tax considerations and set their CEO salaries based on what they saw in the market.

lee.schafer@startribune.com

612-673-4302

Lee Schafer joined the Star Tribune as columnist in 2012 after 15 years in business, including leading his own consulting practice and serving on corporate boards of directors. He's twice been named the best in business columnist by the Society of American Business Editors and Writers, most recently for his work in 2017.